A2 Practice Questions
Internal & External value of money
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True / False
Determine whether the statement is true of false based on your understanding of the topic. Provide a brief explanation or justification for your answer. This will help to demonstrate your understanding of the topic.
Inflation leads to a decrease in the internal value of money, as each unit of currency can buy fewer goods and services over time. True/False
The exchange rate represents the internal value of a currency in relation to other currencies on the international market. True/False:
A country experiencing a current account surplus is likely to have a stronger external value for its currency due to increased demand for its exports. True/False:
Economic stagflation is characterized by high inflation and strong economic growth, contributing to a decrease in both internal and external value of money. True/False:
High unemployment can lead to deflationary pressures, potentially increasing the internal value of money. True/False:
Central banks can influence the external value of a country's currency by adjusting interest rates and engaging in foreign exchange market interventions. True/False:
A decrease in a country's interest rates is likely to attract foreign capital inflows, potentially appreciating its currency's external value. True/False:
A country with a current account deficit is exporting more goods and services than it is importing, leading to a stronger internal value of its currency. True/False:
Political instability in a country tends to strengthen its external value as investors view it as a safe haven for their capital. True/False:
A combination of low inflation and steady economic growth is likely to contribute to a stronger external value of a country's currency. True/False:
Answers
True: Inflation reduces the purchasing power of money, making each unit of currency able to buy fewer goods and services over time due to rising prices.
False: The exchange rate represents the external value of a currency, indicating how much of another currency one unit of the first currency can buy on the international market.
True: A country with a current account surplus is exporting more than it's importing, leading to increased demand for its currency, potentially strengthening its external value.
False: Economic stagflation is characterized by high inflation and stagnant (very low) economic growth, which can contribute to a decrease in internal value but might have a mixed impact on external value due to the complex interaction of these factors.
True: High unemployment can lead to reduced consumer spending and demand, which can create deflationary pressures and increase the internal value of money.
True: Central banks can influence external value by adjusting interest rates to attract or discourage foreign capital inflows, and by intervening in the foreign exchange market.
True: Lower interest rates can attract foreign investors seeking higher yields, which can lead to increased foreign capital inflows, potentially appreciating the currency's external value.
False: A current account deficit indicates that a country is importing more than it's exporting, potentially leading to increased demand for foreign currency and a weaker internal value.
False: Political instability tends to weaken a country's external value as investors perceive higher risk, leading to capital outflows and currency depreciation.
True: A combination of low inflation and steady economic growth is likely to create favorable economic conditions, potentially increasing investor confidence and contributing to a stronger external value of the currency.
Critical Thinking
Answer the following short answer questions, using the provided hint as the foundation for your response
How does inflation impact the purchasing power of money within a domestic economy? Hint: Think about how rising prices affect the value of currency within a country.
Explain how a country's current account deficit might influence its external value of currency. Hint: Consider the relationship between imports, exports, and demand for the country's currency on the international market.
Can a country experience economic stagflation while maintaining a strong external value of its currency? Hint: Reflect on the conflicting effects of high inflation and stagnant economic growth on both internal and external values of money.
Discuss the role of interest rates in influencing both the internal and external value of a country's currency. Hint: Consider how changes in interest rates affect capital flows and exchange rates.
How might a central bank's intervention in the foreign exchange market impact the external value of its currency? Hint: Think about how central banks can directly influence exchange rates through their actions.
Analyze the potential effects of high unemployment on both the internal and external value of money. Hint: Consider the relationship between unemployment, demand, and inflation/deflation, and their implications for currency values.
Can political instability in a country have contrasting effects on its internal and external value of currency? Explain. Hint: Think about how investors' perceptions and reactions to political events might impact currency values.
Contrast the impact of a current account surplus and a current account deficit on the external value of a country's currency. Hint: Consider the implications of trade imbalances for demand and supply of the country's currency.
Evaluate the statement: "Low inflation and strong economic growth always lead to a stronger external value of a currency." Hint: Consider the role of economic indicators, market sentiment, and other factors in determining currency values.
Can a country experience a decrease in its internal value of money while simultaneously observing an appreciation in its external value of currency? Hint: Think about how different economic conditions can impact the domestic economy and the international currency market differently.